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The PutWrite Index: Pluses and Minuses
02/26/2016 8:00 am EST
In regards to the CBOE S&P 500 PutWrite Index, Alan Ellman of TheBlueCollarInvestor.com points out that this is an outstanding tool that demonstrates the value of the put-selling strategy, however, he also stresses that—like all computer-generated blueprints—it also has its limitations.
The PutWrite Index (PUT) is an index created by the CBOE (Chicago Board options Exchange) which acts as a benchmark index that measures the performance of a hypothetical portfolio that sells S&P 500 Index (SPX) put options against collateralized cash reserves held in a money market account. It is similar to the BXM which tracks the performance of a hypothetical S&P 500 covered call strategy.
Comparison to Our Traditional Strategy of Selling Cash-secured Puts
When we sell cash-secured puts, we place an adequate amount of cash into our brokerage account to pay for a possible future stock transaction (buy the shares) if the put option is exercised. In the PutWrite Index, an added element of buying one- and three-month Treasuries in a specific rotation is added to the strategy. Here’s how it works:
- Every 3rd Friday of the month when the puts expire is known as the roll date which is set up in sequences of three roll dates. In roll dates, one and two, 1-month Treasuries are purchased and in roll date three, 3-month Treasuries are purchased. The amount purchased would be adequate to finance the maximum possible loss from final settlement of the SPX puts should SPX move to zero. This is known as collateralizing the puts. As portfolios are re-balanced on the roll dates, the portfolio will be long 1- and 3-month Treasuries and short 1-month SPX puts
- On roll dates at-the-money puts are sold that do not exceed the current value of SPX
- The cash proceeds from put sales are invested in 1- or 3- month Treasuries depending on the roll date of the 3-month sequence
- If puts expire in-the-money, the final settlement loss is financed by the Treasury Bills
- The number of puts sold at each roll is determined by the maximum final settlement loss to account for a worst-case scenario (S&P 500 drops to zero)
The PutWrite Index generates returns slightly higher than the S&P 500 with less portfolio volatility and higher risk-adjusted returns. The index performs particularly well in bear markets where put premiums are highest as volatility tends to be elevated and puts are being purchased to hedge portfolio risk. Here is a comparison chart of PUT vs. SPX from February, 2015 through February, 2016:
Why Retail Investors Can Do Much Better
So far, this strategy doesn’t seem so bad but we can absolutely out-perform this index as we can any computer-generated strategy where one size fits all and every situation is handled in a robotic fashion no matter what extenuating circumstances exist at the time. Cases in point: To read the entire article, click here…
By Alan Ellman of TheBlueCollarInvestor.com
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